Dollar dives after Reserve Bank lifts rate to 3.5pc

Reserve Bank Governor Graeme Wheeler said this morning that the economy appears to be adjusting to this year's monetary policy tightening. Photo / Mark Mitchell

Reserve Bank governor Graeme Wheeler has raised the official cash rate as expected, while signalling a pause in rate hikes to assess the impact of moves so far this year. The kiwi dollar sank after Wheeler said its strength was "unjustified" and that the currency could have "a significant fall."

"Encouragingly, the economy appears to be adjusting to the monetary policy tightening that has taken place since the start of the year," Wheeler said in a statement in Wellington. "It is prudent that there now be a period of assessment before interest rates adjust further towards a more-neutral level."

The quarter point increase in the OCR to 3.5 per cent was forecast by all 16 economists in a Reuters survey. The market has become increasingly convinced that the central bank will wait, possibly until 2015, before hiking again in the face of falling commodity prices, relatively tame inflation and signs house price inflation is moderating.

The New Zealand dollar dropped to 86.31 US cents from 87.02 cents immediately before the statement was released. The trade-weighted index fell to 80.35 from 80.97.

Wheeler said today that the speed and extent of further OCR increases "will depend on the assessment of the impact of the tightening in monetary policy to date, and the implications of future economic and financial data for inflationary pressures."

The New Zealand economy is expected to grow at an 'annual average' pace of 3.7 per cent in calendar 2014. The last forecast it gave was on a different basis, for the 12 months ended June 30, which it forecast at 4 per cent in last month's monetary policy statement. Wheeler omitted last month's comment about the economy having "considerable momentum."

Construction, particularly in Canterbury, was "growing strongly", with strong net migration adding to housing and household demand. But house price inflation "has moderated further since the June statement."

Wheeler also noted the decline in export prices for dairy products and timber, saying that "would reduce primary sector incomes over the coming year."

"With the exchange rate yet to adjust to weakening commodity prices, the level of the New Zealand dollar is unjustified and unsustainable and there is potential for a significant fall," he said.

Westpac Bank chief economist Dominick Stephens said last week that the central bank might consider intervening in the currency market by selling the kiwi, once today's review was out of the way. Any intervention "would likely come at a time sentiment was already negative for the kiwi to maximise the impact," he said.

The Reuters survey shows that before today economists were expecting the OCR to rise again in December to 3.75 per cent, reach 4 per cent by March and 4.25 per cent by June next year.

Wheeler repeated that inflation "remains moderate" while noting that strong output growth is absorbing spare capacity in the economy, which was expected to stoke non-tradables inflation.

The Reserve Bank aims to keep annual inflation near the mid-point of its 1 per cent-to-3 per cent target range on average, over time, which it expects to achieve following today's OCR increase.

In the June MPS it saw inflation peaking in the currently cycle at an annual 2.1 per cent in the second quarter of 2015. Since then, government figures have shown the consumers price index rose 0.3 per cent in the second quarter, meeting the bank's forecast, while the annual rate of 1.6 per cent, just missed the bank's 1.7 per cent expectation.

Wheeler repeated that global financial conditions remain very accommodative, while economic growth among New Zealand's trading partners "has eased slightly" in the first half of the year, which "appears to be due to temporary factors."

Here is the text of the Reserve Bank's statement:

"New Zealand's economy is expected to grow at an annual pace of 3.7 per cent over 2014. Global financial conditions remain very accommodative and are reflected in low interest rates, narrow risk spreads, and low financial market volatility. Economic growth among New Zealand's trading partners has eased slightly in the first half of 2014, but this appears to be due to temporary factors.

Construction, particularly in Canterbury, is growing strongly. At the same time, strong net immigration is adding to housing and household demand, although house price inflation has moderated further since the June Statement.

Over recent months, export prices for dairy and timber have fallen, and these will reduce primary sector incomes over the coming year. With the exchange rate yet to adjust to weakening commodity prices, the level of the New Zealand dollar is unjustified and unsustainable and there is potential for a significant fall.

It is important that inflation expectations remain contained. Today's move will help keep future average inflation near the 2 per cent target mid-point and ensure that the economic expansion can be sustained. Encouragingly, the economy appears to be adjusting to the monetary policy tightening that has taken place since the start of the year. It is prudent that there now be a period of assessment before interest rates adjust further towards a more-neutral level.

The speed and extent to which the OCR will need to rise will depend on the assessment of the impact of the tightening in monetary policy to date, and the implications of future economic and financial data for inflationary pressures."